Many initiatives offer opportunities for action now, including new proposals from the Harvard Kennedy School, which are being studied by the World Bank
Every spring, central bankers, ministers of finance and development, business leaders and policy experts converge on Washington DC to discuss issues of global concern. During April 2023's IMF and World Bank Spring Meetings, discussions and action plans converge on a single goal: financing an energy transition that is equitable for emerging markets and fast enough to maintain the Paris Agreement goals. A $4 - 6 trillion investment annually is required by 2030 to meet these twin goals. At last count, we are still in the hundreds of billions, leaving a ‘climate finance gap’ that one week in Washington, even a successful one, will not fill.
Filling this gap, trillions in size and orders of magnitude greater than governments are on track to meet requires deep collaboration between public and private sectors. To give one extreme, but still insufficient, example, even if all multilateral development banks dedicated all their funds to the green transition, it would only amount to 4% of the capital needed. On the other hand, just 1.4% of global private financial assets - estimated at $410 trillion - would be more than enough.
The need for increased climate investments - the majority of which must come from private sector capital - is most acute in emerging markets. These economies will be the engine of the global economy for the next 30 years. They are predicted to see almost double the growth of G7 countries from now to 2050. That’s good for global prosperity, but bad for emissions, as these countries are highly dependent on carbon-intensive energy sources, such as coal.
But high emissions are not the only problem emerging economies face. Total debt among emerging markets is at a 50-year high. This imperils economic growth by constraining government action and it endangers the flow of new green finance. Of the $632 billion of global climate finance in 2019/2020, 75% went to developed economies. A combination of high government indebtedness, plus higher risk in developing countries, means that private finance is likely to retrench, not increase, without public action.
As officials meet in Washington this week, expectations are high for a number of proposed reforms that, if achieved, could transform the global financial architecture. For a start, the Spring Meetings will address reforming the World Bank, including the Bridgetown Initiative, a plan championed by Barbados’ Prime Minister, Mia Mottley and France’s President Emmanuel Macron, to transform the international financial system. These discussions will set the tone for a flurry of negotiations this year, culminating in the Mottley-Macron ‘Summit for a New Global Finance Pact’ in Paris in June and COP28 in November.
So, if the balance sheets of development banks amount to only 4% of required capital, how can the Spring Meetings kickstart smart public policy to ensure global growth is not only robust, but also green? The answer is incentivising private investment to go where we want it and disincentivising private money from where we don’t. In other words, policymakers need to change the corporate calculus for green investment from just an ethical and social responsibility to an economic imperative.
Achieving green parity on green investments
When managers and investors decide where to allocate capital, decisions are driven by risk-adjusted return. If one project or business generates a greater return than another, at a comparable or lower level of risk, that’s where money will flow. What does this mean for the green transition?
Green investments need to be made less risky or to yield a higher return. At the same time, fossil fuel investments must be made less profitable or have their risk increased. When global investments reach what we call 'green parity,' where risk-adjusted returns for sustainable projects rise to meet the falling returns of pollutive investments, market forces will push trillions of dollars to the global energy transition.
Role of public financing mechanisms and carbon markets
There are ready solutions that policymakers can utilise to reach green parity. A new proposal from the Harvard Kennedy School, for example, builds on the now-finalised Article 6.2 of the Paris Agreement to put forward a novel approach to creating impact. Article 6 set up the architecture for transferring carbon credit at the sovereign level; emissions reductions in one country can count for the Paris Agreement targets of another. This has the potential to increase capital going to emerging markets, as richer countries finance decarbonisation abroad to meet their Paris commitments. Article 6 could also drive up the total ambition of climate goals, with developed countries investing in the most effective emissions reductions globally, while still safeguarding energy security and affordability at home.
The strength of the Harvard proposal, of which one of the authors of this Agenda commentary is a co-author, is that unlike traditional approaches to Article 6 and carbon markets, investors only receive carbon credit to the extent they bring down a project’s weighted average cost of capital. This incentivizes investment in more risky projects at cheaper rates, as more concessional investments receive more Article 6 credit. The World Bank is now studying and implementing the Harvard proposals and a pilot is being planned for COP28. Cheap financing for green investments, mobilized by Article 6 or any other means, will lower financing costs, increasing free cash flow and lower risk. Lowering the cost of capital also increases funds available to pay commercial investors, increasing project returns and incentivising private interest.
If de-risking projects is the carrot for green investments, policy must also apply a stick. New initiatives, such as the European Union’s Carbon Border Adjustment Mechanism (CBAM) or Singapore’s Carbon Tax, create a 'carbon liability' that companies must pay proportional to their emissions. In this context, the Harvard paper describes a private sector approach to Article 6 that builds on a rich academic literature around carbon pricing. Under the private sector approach, governments outsource the acquisition of Article 6 credits to the private sector by allowing 'carbon liabilities' to be met with carbon assets, i.e. Article 6 credits. Expanding carbon pricing to more jurisdictions and more sectors is imperative to bring down returns for high-emitting sectors. Allowing firms to pay in Article 6 credits can ensure funds raised will most effectively subsidise green projects.
The role of philanthropic finance
Looking at the other side of the 'green parity' equation, the risks associated with green investments must be bought down. Many high-emitting emerging economies will not have the public or private capital available domestically to fund their energy transition. Working with multiple international actors to attract foreign investment poses an inherent coordination problem, which more patient, concessionary loans or grants, such as philanthropic capital, could overcome.
One emerging blueprint for how philanthropic giving can support the coordination of multiple actors is through the Just Energy Transition Partnerships (JETPs), which provide a platform for policymakers, development actors and private investors to align and synchronise contributions, providing transparency into pipelines of investable renewable energy projects. Philanthropies could play a stronger and more meaningful role in such multistakeholder, public-private cooperation mechanisms to support emerging economies in financing their energy transition.
Although in 2021, philanthropic giving equated to $810 billion, only 2% went to climate projects. The World Economic Forum’s Giving to Amplify Earth Action (GAEA), a coalition of philanthropies, academic institutions, companies and public organizations, will, in 2023, identify where philanthropic giving can be most powerful to help unlock the $3 trillion needed each year from public and private sources to tackle climate change and nature loss.
2023 is a year to target green parity
Policymakers, development banks and climate finance experts have set 2023 as the year to rewire the international finance system to deliver on climate action. Their task is clear: to target green parity for renewable energy in emerging economies, which will itself unlock a step change in private sector investment. This will only be possible if governments, multilateral finance and private finance partners deliver investments on the ground to achieve a low-carbon energy transition.
Photo: Green investments need to be made less risky or to yield a higher return